Definition of Swaps and Forward
- SWAPS: A swap is a contract by which two parties agree to exchange a series of money flows at a future date. These flows can, in principle, be a function of either short-term interest rates or the value of the stock market index or any other variable. It is used to reduce the cost and risk of financing a company or to overcome the barriers of the financial markets. FORWARD: A term or forward contract is any whose settlement is deferred until a later date stipulated therein. Forward transactions are one of the most common derivative instruments in all types of financial activities.
CLASSIFICATION OF SWAPS AND FORWARDS
Swaps are divided into:
- Interest rate swaps (vanilla swap): contract by which one party to the transaction agrees to pay the other party an interest rate fixed in advance on a nominal also fixed in advance, and the second party agrees to pay the first a variable interest rate on the same nominal. The only exchange that takes place is the principal interest payments, while the principal payments do not participate in the transaction. Currency swaps:It is a variant of the interest rate swap, in which the nominal on which the fixed interest rate is paid and the nominal on which the variable interest rate is paid are in two different currencies. The traditional form of the exchange rate swap generally denotes a combination of a purchase (sale) in the spot market and an offsetting sale (purchase) for the same party in the forward market, but this it can sometimes refer to offsetting transactions at different maturities or combinations of both. Swaps on raw materials: After the appearance of these swaps, it has been possible to separate the market price risk from the credit risk, and turn a producer of raw materials into a simple factory that processes materials without taking price risk.Stock index swaps: The stock index swap market allows the performance of the money market to be exchanged for the performance of a stock market.
- Foreign exchange market intermediaries Brokers that are members of the clearing houses of foreign futures and options exchanges, classified as first category according to general regulations adopted by the Banco de la República Foreign financial entities classified as first category according to general regulations adopted by the Banco de la República.
TYPE OF PROFITABILITY AND RISK PRESENT
- Risk
SWAPS
- Differential risk: If a swap is hedged with a bond, and there is a change in the swap differential with respect to the bond, it may cause a loss or a profit in the profitability of the swap Basis risk: When a swap is hedged with a forward contract and there is a difference between the reference rate and the rate implicit in the forward contract, causing a loss or a profit Credit risk: Probability that the counterparty will not meet its obligations Reinvestment risk: It is derived from credit risk, when there are changes in the payment dates, it is necessary to reinvest on each rotation date Exchange rate risk: If there is a positive fluctuation of the currency (s) that are to settle when the transaction is made (purchase or sale), that is,if at the end of the commercial operation they have to pay more of their own currency (or any other) to acquire the same amount of the currency that was agreed in the contract. What affects the final cost of transactions.
FORWARD
- Credit risk Interest rate risk: When there are fluctuations in interest rates, which affects the final cost of transactions Exchange rate risk
Cost effectiveness
FORWARD
Presents variable income (according to interest rates)
- Forward rate over interest rate:
Where:
t = forward interest rate defined over time (Tt)
T = longer time; t = less time
R = interest rate with time T; r = interest rate with time t
- Forward rate over exchange rate:
EXPEDITION AND ACQUISITION
SWAPS and FORWARD transactions are normally carried out by phone or internet and the deal is closed when an agreement is reached on the coupon rate, the base for the floating rate, the days base, start date, expiration date, rotation dates, applicable law and documentation.
The transaction is confirmed immediately by telex or fax followed by a written confirmation. The documentation used in the main currency centers is generally in one of two standard forms, that offered by the British Bankers Association (BBAIRS) or the International Association of Swap Agents (ISDA).
MARKET OVERVIEW
The swap and forward market, in general, in our country, is handled by conventional currency users who are:
- Importers of goods and services: In the normal course of their operations, they carry out transactions that are agreed for a certain amount of a currency (or several) to be canceled at a future date, for receiving goods or services from another country.: In the normal course of their operations, they carry out transactions that are agreed for a certain amount of a currency (or several) to be received at a future date, for sending goods or providing services to another country Debtors of foreign currency obligations: That they are not other than companies that acquire credits in any other currency other than Colombian and / or operations payable in the future.Other agents (Private or Public Companies, Institutional Investors, Private Investors, etc.):Due to the nature of their activities, they are exposed to variations in exchange rates or interest rates
PLACEMENT PROSPECTS (applied case)
- SWAPS
If a company plans to fix floating-rate debt through an interest swap and its expectations regarding the behavior of rates are uncertain, it could purchase a put option on the treasury bond that has a similar maturity. As interest rates rise, the option is exercised to offset the high cost of the swap generated by the rise in rates. On the contrary, if the rates fall, the option will expire without value, but benefit will be obtained by having fixed variable rate debt at a lower fixed rate than the prevailing one.
- FORWARD
A company that exports (coffee, flowers, coal, etc.) to other countries, and is therefore exposed to the exchange rate between its local currency and the foreign currencies in which it charges for its sales, can hedge in advance its risk of exchange by selling forward the currencies that you expect to receive in the future.
Download the original file
